U.S. Economy Following Path of Greece & Spain?

By Michael Lombardi, MBA Published : June 8, 2012

The U.S. Congressional Budget Office (CBO) has issued another scathing report on the state of the mountainous U.S. national debt.

The CBO says the national debt will double by 2026 and reach 200% of gross domestic product (GDP) by 2037 unless firm action is taken to stem America’s annual trillion-dollar deficits. (For the benefit of my new readers, Greece got into trouble when debt-to-GDP in that country hit 130%.)

There is no doubt tax increases and radical spending cuts are needed to reduce the national debt. The CBO notes that, if congress allows the tax increases and the removal of spending programs on January 1, 2013—the “fiscal cliff”—then it will be the important first steps in reducing the budget deficit and so the national debt.

However, as I’ve mentioned many times in these pages, if congress does allow these tax increases and removal of spending programs to occur on January 1, 2013, it will send the U.S. economy further into recession. Does the elected government want to be responsible for sending the economy into a recession after just being elected in November? Not a chance.

As usual, the CBO assumes some pretty rosy numbers in its calculation of the national debt. The CBO assumes that the 10-year U.S. Treasury note will average roughly three percent during the next 20 years!

I can’t see this happening; long-term interest rates will eventually rise, which will increase the interest payments on the national debt, which will widen (not shrink) budget deficits…leading to a doubling of debt-to-GDP much sooner than 2037.

Of course, as the economy worsens towards the end of this year and the beginning of next year, the CBO doesn’t project more government spending to help boost the economy. The CBO also assumes that there will be no third round of quantitative easing (QE3).

The CBO has done a great service in advising the administration that the continued trillion-dollar budget deficits must be stopped and the expanding national debt must be addressed, now.

But its projections are based on some very optimistic assumptions. What is most frightening, dear reader, is that if QE3 and more government spending programs are enacted, then budget deficits will balloon and a doubling of the national debt could occur this decade!

On our current path, our economy could be worse than that of Spain or Greece by the end of this decade.

Spain’s Treasury minister—equivalent to Timothy Geithner here in the U.S.—issued a public plea yesterday to the European Central Bank (ECB) stating it was “technically impossible” for Spain to bail itself out.

While everyone assumed the future of the European Union was centered on the upcoming elections in Greece, Spain and the ECB instead have taken center stage. Spanish banks need money from the ECB and they need it now.

How dire is the situation? The Group of Seven (G7) industrialized nations have called an emergency meeting to discuss the crisis in the European Union, with Spain at the top of the agenda. The meeting will take place at the end of June.

But the situation is so bad that the Spanish banks and Spain’s Treasury minister are not waiting on the G7 meeting or the ECB.

The Spanish banks have decided to open their books and allow auditors from Germany and the U.S. to evaluate their financial statements in order to decide how to draft a bailout solution that would work for all sides, including the ECB and Germany.

The current estimates have the Spanish banks needing anywhere from 75 billion euros to 100 billion euros from the ECB.

These estimates will be moved higher—and the ECB knows it—because, as I’ve highlighted in these pages, the real estate collapse in Spain continues. As house prices fall relentlessly in Spain, the mortgages that the Spanish banks hold are worth less and less.

The fact that Spanish banks are opening their books to outside auditors smells of desperation and illustrates how badly they need ECB money now.

The ECB—or Germany really—refuses to provide more money to Spain without stipulations attached. The Spanish banks are hoping that if Germany is allowed to send its own auditors to evaluate the Spanish banks, bailout money will follow.

Right now, the interest rate on Spanish 10-year debt has risen again to over 6.6% as the market realizes the distress that Spain is in. The market understands that the economic numbers continue to point to an economic contraction in Spain.

Unemployment in Spain remains at elevated levels (about 25%), which ensures that the value of the debt on the books of Spanish banks will continue to deteriorate.

Faced with this scenario, the Spanish banks cannot go to market and pay such high interest rates; they simply don’t have the money to pay the high interest costs.

The only way they can obtain low interest rates is via a bailout from the ECB. If the European Union wants to remain together, the ECB will need to do something to help Spain…soon. The ECB cannot allow Spanish banks to go bankrupt, because this would tear the European Union apart…unless that is the plan.

More Notes from Michael:

I thought my readers, especially the gold bugs, would be interested in this statement released yesterday by my esteemed colleague and fellow financial analyst, Robert Appel, BA, BBL, LLB:

“As this is written, gold is trading precisely halfway between the two key pivots, 1550 and 1630. This is hardly bad news given the recent tests in the 1530 area, within the broader context of a multi-year consolidation (which, make no mistake, is what this actually is). Yet, to follow the headlines today, you would think that gold was taken to the woodshed and beaten to death. You would think that Bernanke absolutely denied there would be anymore easing. Both these statements are not true, yet that is what the media is selling today. Nothing changes in our ‘accumulate the miners’ strategy.”

Where the Market Stands; Where it’s Headed:

When you look at the stock market, the valuations are favorable. On our web site, www.profitconfidential.com, we show the Dow Jones Industrial Average trading at only 14 times earnings with a dividend yield of 2.7%. Since the 10-year U.S. Treasury is below 2%, you’d think the stock market would be rallying at its current valuation.

But the market is not moving higher for good reason. The stock market is a leading indicator. It takes the emotions of all the players in the market, from investors to the companies that trade in it, all the fear, and all the greed and acts as a gauge as to what will happen six to 12 months out.

What the stock market is saying today is that it expects the U.S. economy to slow dramatically…that the current yield on the Dow Jones Industrial Average of 2.7% might have to be adjusted as companies make less money and thus distribute less cash to their investors. The stock market is sensing that today’s current rate of corporate earnings may not be sustainable. And that spells trouble for stock prices.

What He Said:

“Overbuilt, over-speculated, over-financed and overdone. This is the Florida real estate market right now. For those looking to buy for personal use or investment, hold off! The best deals are yet to come. I continue with my prediction that the hard landing in the U.S. housing market, which is now affecting lenders, will have significant negative effects on the U.S. economy.” Michael Lombardi in Profit Confidential, April 3, 2007. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.